A guaranteed pension, but with risks attached

For many people, the most soul-destroying part of saving for a pension is getting to retirement and having to use your precious fund to buy a disappointing annuity. But insurers are introducing a new product from the US that they claim will revolutionise retirement income.

UK-based insurer Aegon is the latest to offer 'insured retirement plans', or IRPs, which invest in the stock market. You can buy the plan at any age between 55 and 70 and, if you wish, change it into a more traditional annuity by age 75.

But the radical element of an IRP is that it offers the guarantee of a minimum monthly income even though you are investing in shares. And if markets rise, your monthly income may also go up.

Until now, the opportunities for pensioners to put their pension funds into products that offer both a guarantee and stock market exposure have been very restricted.

So why is it, then, that leading advisers are lukewarm about Aegon's Income for Life product? Because they think that the price that people have to pay for getting that guarantee - up to 1.6 per cent a year - is too high. 'With the relatively low expectations that we have of investment performance over the next few years, charges of between 0.5 and 1.6 per cent eat into performance too much for most people,' says Stuart Bayliss of Annuity Direct.

Tom McPhail of Hargreaves Lansdown agrees: 'Standard Life, Axa and the Pru are all looking at it - but the reason they have been slow to jump in is that they have all struggled to square the circle on the pricing.'

UK pensioners have been able to buy IRPs for about 18 months from three other US companies - MetLife, Hartford and Lincoln. But 'tiny amounts' have been invested, says Bayliss. He finds that nearly every time he takes someone through the figures and judgment calls (relating mainly to inflation and investment risk as well as life expectancies and changing circumstances) they decide that other products are better for them.

It has been easier to design IRPs for the US because they are sold in a more favourable tax environment, but the UK has still to crack it. Michael Rudge, chief executive of Hartford, does not claim that his company can or will push the price of the guarantee down, but he says: 'Hartford has had 15 or so years of experience of doing this in the US and we believe our price is a fair one. In the US there are new features that change the dynamics on pricing.' For example, while most companies adjust the monthly payment rate just once a year, some companies have started doing it more often. And while many products cap the extent to which policyholders can benefit from stock market rises, some newer products have taken off these caps.

However, the advisers do take their hats off to Aegon for innovation. Longer life expectancy and global investment markets no longer make it the obvious decision for retiring 60-year-olds to buy an annuity. In the days when men tended to die just 10 or 12 years after retirement, insurers could offer them attractive annuity incomes - not least because they could predict investment conditions far better over 10 years than for the 25 years or so that pensioners tend to live now.

'There is a strong argument for many people to defer taking an annuity until they are in their seventies,' says McPhail. If you can tolerate the risk, you can stay invested in the stock market and draw some of your pension funds to live off. And keener rates should be available for 75-year-olds because insurers have to make fewer assumptions about the future than they would for a younger person.

Those who are nervous about investing their money in a new product could split their fund between a straightforward annuity and an IRP. But all agree that you should only ever risk your money in stock markets if you can afford to lose a substantial part of it.

And you should not think of doing it if you have less than £50,000 in your fund.

Even with a £100,000 fund, you are taking big risks: for example, the FTSE 100 fell 18 per cent in the first three months of this year. In circumstances like that, you can lose a lot of your capital if you were planning on withdrawing it later.